Question

A particular company currently has sales of $250 million; sales are expected to grow by 20% next year (year 1). For the year after next (year 2), the growth rate in sales is expected to equal 10%. Over each of the next 2 years, the company is expected to have a net profit margin of 8% and a payout ratio of 50% and to maintain the common stock outstanding at 15 million shares. The stock always trades at a P/E of 15 times earnings, and the investor has a required rate of return of 20%. Given this information,
a. Find the stock’s intrinsic value (its justified price).
b. Use the IRR approach to determine the stock’s expected return, given that it is currently trading at $15 per share.
c. Find the holding period returns for this stock for year 1 and for year 2.